American Capital Agency Corporation (AGNC) has proven to be the best-of-breed in the mortgage real estate investment trust business (mREIT). I will articulate this opinion based upon known facts, SEC filings, and peer-to-peer comparisons. The 2011 third quarter had many curve balls thrown at the mREIT industry. Curve balls included a SEC request for sector feedback, a pending Operation Twist impact upon long-term GSE-MBS interest rates, and unfounded nationwide refinancing rumors.
Only three mREITs were able to achieve third quarter analysts' dividend expectations: American Capital Agency Corp. (AGNC), Two Harbors Investment Corp. (TWO), and Hatteras Financial Corp (HTS). As an AGNC shareholder, I keep searching for a chink in American Capital Agency's armour. I can not find one. It keeps producing quarter-in and quarter-out.
American Capital Agency Corp. (AGNC)
I believe American Capital Agency will continue to provide out-sized returns over the next 2-3 years. Gary Kain, American Capital Agency's President, has built a solid management team. The team has provided AGNC-shareholders consistent results that outperform the respective mREIT sector. The company has paid a $1.40 dividend for 9-quarters. The book value per share was $26.76 as of June 30th, 2011.
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Operation Twist Overall Impact
As expected, Operation Twist has created a tightening of new mREIT net yield spreads via flattening the yield curve. This net yield spread has been reduced by approximately 30-basis points. Operation Twist caused long-term Treasury Bond and Government Sponsored Entity (GSE) Mortgage Backed Securities (MBS) to compress. This impact is negative to agency mREIT profits, assuming leverage remains constant.
Operation Twist has provided a positive outcome to agency mREIT's book value per shares. A decrease in long-term GSE-MBS yields will increase American Capital Agency's book value per share. This data should be confirmed in October when September 30th, 2011 data are provided.
Operation Twist Impact upon Book Value per Share
American Capital Agency should have a higher book value per share for the September 30th, 3rd quarter. American Capital Agency could report lower dividends in the future based upon the current net yield compression. This assumes leverage is not increased. The stock price is a reflection of the book value per share. American Capital Agency's assets have zero credit risk. The assets are 100% GSE-MBS.
American Capital Agency's Best of Breed Background
American Capital Agency has actively recruited GSE experienced management. American Capital Agency's chief risk officer, Peter Frederico, was previously executive vice president and Treasurer of GSE Freddie Mac.
8 Reasons to Buy American Capital Agency
- American Capital Agency has provided the best mreit total annualized rate-of-returns over the past 3-years. Per the below table, AGNC has provided investors a 23.9% total annualized rate-of-return between October 30, 2009, thru September 23, 2011.
- American Capital Agency was one of only three companies, for the third quarter, that provided shareholders with the expected dividends. All other mREITs reduced the dividend.
- American Capital Agency has a small swap net position, and shorter-duration swap position. The mitigates the risk of negative book value per share implications when the interest rates go the against the hedge. Invesco Mortgage Capital Inc. (IVR) has proven it was not positioned correctly in swap positions.
- Unfortunately, U.S. home owners have continued to experience net home valuations. Many home owners are unable to refinance due to being under water on their mortgage balance. Because of this, the desire to provide refinancing options to U.S. homeowners has become a political issue. American Capital Agency has proven to be heads above the competition in possessing ex-Government Sponsored Enterprise [e.g., Fannie Mae FNMA.OB)] executives on their leadership team. The ex-GSE management, within American Capital Agency, know how the various Federal agencies interlink and operate: Treasury Department, Housing Agencies, Federal Reserve, Congress, GSE's and House of Representatives.
- American Capital Agency, by any measuring stick, is 100% transparent in its communication to retail shareholders. American Capital Agency's website is a wealth of information that other mreits do not offer. This provides a level of comfort, and trust, to AGNC shareholders. It goes above and beyond other mREITs in transparency.
- American Capital Agency, due to their ex-GSE management team, has proactively addressed the prepayment risk. American Capital Agency has GSE MBS positions which are less likely to experience prepayment. These GSE MBS include assets with a lower likelihood of prepayment due to lower coupon rates; and shorter-duration where Operation Twist buybacks are less likely to occur.
- American Capital Agency is active in minimizing ownership in to-be-announced (TBAs) trades with increased likelihood of prepayment risk.
- American Capital Agency, via the GSE experienced management, is active in selecting reduced prepayment risk GSE-MBS. It also includes taking positions in prepay-protected specified pools and collateralized mortgage obligations as deemed necessary.
Retail Shareholder Hedging Possibilities
American Capital Agency shareholders must know the following risks apply to the AGNC equity:
- Prepayment Risk
- Interest Rate Risk
- Credit Risk: AGNC is a pure 100% agency MBS. This implies there is zero credit risk with GSE-MBS assets.
Shareholders can utilize put options and collar option positions to mitigate capital losses. Shareholders can benefit by owning American Capital Agency (AGNC) and be proactive, via put options, to reduce the net capital exposure.
3-Year mREIT Peer-Group Analysis
Hatteras Financial is a 100% agency-mREIT. The company invests in solely agency-MBS. HTS was one of three mReits (i.e., AGNC, HTS, TWO) to achieve their expected 2nd quarter dividend.
I have concerns about the operations of ARR and its external management team. Those concerns were expressed in Digging Deeper Into Armour Residential mREIT.
Disclosure: I am long AGNC, CYS, NLY, HTS.